Roth conversion arithmetic favors paying tax from taxable assets

A $100,000 Roth conversion taxed at 25% generates $25,000 of tax, and paying that bill from outside the converted funds leaves the full $100,000 in the Roth, according to a Journal of Financial Planning paper.

The May 2023 paper is by Edward F. McQuarrie, professor emeritus at Santa Clara University's Leavey School of Business, and James A. DiLellio, associate professor at Pepperdine University. Its stated goal is to lay out the arithmetic that conversion outcomes guarantee, not projections that depend on an uncertain future.

Withholding the tax from a converted balance puts $75,000 in the Roth; paying it from a taxable account puts $100,000 in the Roth. The second option costs the client $25,000 outside the Roth, and advisors running conversions must make that choice explicitly.

The result is arithmetic, not a forecast. Paying the tax from outside keeps the $25,000 inside the Roth to compound untaxed; withholding leaves it in a taxable account where its growth is taxed each year.

The result holds only under fixed inputs: every account holds the same asset, stocks return 10% a year nominally, and a single 25% rate applies. The authors call the approach deterministic and distinguish it from models that incorporate future uncertainty.

The outside-funds answer assumes the tax payment comes from an ordinary taxable account equal to the tax due; a client whose assets are all inside the IRA being converted has nothing outside to draw on. Advisors must substitute client-specific rates and returns, and changing the inputs is modeling the paper does not claim to have run.

The paper gathers arithmetic that has circulated in the planning literature — Crain and Austin (1997), Horan, Peterson and McLeod (1997) and Reichenstein (2020) — into one framework aimed at the expected payoff from a conversion. It answers where the tax should come from, given a rate and return; it does not project whether a client's rate five years from now will resemble today's.